If you are looking for a new financial incentive to attract and retain your most important executives, look no further. Deferred compensation may be an important feature that you have yet to offer in your company’s retirement benefits.
KEY POINTS
- NQDC plans let your top executives defer a significant amount of money from their compensation, allowing them to defer taxes on that amount until it is paid
- This should be a serious consideration if companies want to retain valuable employees that have already maxed out their 401(k) contributions
- Distributions can be paid out upon retirement or upon shorter, 5 to 10-year terms
- There are tax benefits for both employer and employee
What is Deferred Compensation?
Deferred compensation is when an amount of an employee’s compensation is postponed to be paid out at a later time and often supplements participation in a 401(k) plan. This is a compensation strategy that both employers and employees can greatly benefit from.
What are the types of Deferred Compensation?
Although there are different types of deferred compensation, it can be generally classified into Qualified Deferred Compensation (QDC) and Non Qualified Deferred Compensation(NQDC).
| QDC | NQDC | |
| Governance | Governed by ERISA | Not governed by ERISA |
| Limits on Contribution | Contributions of employees cannot exceed $20,500 in 2022 | Fewer restrictions |
| Security | Safe from creditors in case of bankruptcy or default | Not safe from creditors in case of bankruptcy or default |
| Employee Enrollment | Must offer enrollment for all employees | Certain groups of employees can be selected |
How do Non-qualified Deferred Compensation Plans work?
409(b) plans, NQDC, or “golden handcuffs,” allow employers to attract and retain valuable employees because there are fewer ERISA restrictions and do not cap contributions at $20,500. NQDCs are contract agreements between the employer and the employee on the amount and withdrawal date. It can be deposited into a “401(k) look-alike plan,” or even be used as a life insurance premium.
(Check out what our CEO has to say about Deferred Compensation: Hint – he calls it a “best kept secret”)
NQDC plans offer the most benefits to high-paid employees or executives. These employees have most likely already maxed out their 401(k) contributions (a very small part of their salary) and are looking for an additional savings vehicle for retirement. Apart from securing their retirement, there is also the possibility of a lessened tax burden as the executives defer taxes on the money until it is paid.
When does deferred compensation have to be paid?
On the employee side, most often compensation is paid when the employee retires, but it can depend on 5 to 10-year terms, disability, emergency, or other factors. Many plans allow employees to schedule payouts later during their career, not just when they retire, so they can defer compensation to cover shorter-term goals like paying for a child’s education. Also, they can change their deferral amount from year to year.
On the company side, deferred compensation can be retained if the employee is fired, leaves for a competitor, voids the agreement, or essentially “gives up” their benefits. There can also be costly penalties for an early withdrawal, an additional incentive for your key employees to stay with the company long-term. Additionally, if the company goes under, the employer is not necessarily required to pay deferred compensation as those assets are now subject to creditors.
Case Study: How It Works
An employee is 60 years old and plans to retire at 65, making $500,000 per year. The company gives them the opportunity to defer up to 20% of their compensation over 10 years. If they take the income now, they will pay a 37% tax rate on $100,000 of income, for a total tax bill of $185,000. But if they defer until retirement, they could be looking at a 24% tax rate, for a tax bill of $120,000.
The employee saves on taxes, grows their savings, and secures their retirement.
The company retains a valuable executive for a longer period, has a deferred taxable write-off, and can invest the funds during the agreement period.
It’s true. Figuring out all the complexities of your company’s retirement plan can be difficult without expert advice, but it doesn’t have to be. Our team of 401(k) Advisors is here to make the process easy for you. If you have any questions about how a Deferred Compensation Plan can benefit you, your executives, and your bottom line – contact us today.
